In my last column Pension Reality in Orange County, I discussed an interesting court case that deals with increases to employee benefits and described how such benefits constitute a liability. Not surprisingly, CalPERS filed an amicus brief in the case and questions this assertion. Clearly, the leaders of CalPERS either do not understand economic reality or they stand up for their members regardless of the truth.
The amicus brief by CalPERS has two arguments, the first of which is that the enhanced pension benefits based on prior years of service does not violate the constitutional debt limit. This argument has two subpoints: first, the estimated costs are actuarial estimations and thus not a liability; second, the government agency’s cost is a contingent liability.
That the pension obligation due to prior services is an actuarial estimation seems a strange argument to make because accounting is filled with hundreds of estimations. Corporations routinely estimate such things as the age and salvage value and the fair value of property, plant, and equipment; allowance for bad debts and fair value of residual cash flows arising from the securitization of receivables; allowance for inventory obsolescence; fair value and recoverability of intangible assets with indefinite lives; fair value and recoverability of goodwill; fair value of investments; future income tax assets and liabilities; accruals for payroll; accruals for restructuring and workforce reduction costs; accruals for deferred revenues; accruals for taxes and warranties; insurance liabilities and reserves; stock-based compensation; and fair value measurements of derivative instruments require estimates of future cash flows, the risk-free interest rate, and volatility. Disallow estimations and one erases the accounting profession from existence.
With respect to pension estimates, the AICPA correctly stated that “actuarial science is well established and there are numerous instances in which financial statements are affected by actuarial calculations and are reliably stated.” In short, CalPERS’ attack on actuarial assumptions is a straw man. If the Court would accept that argument, it would deny the existence of virtually all assets and liabilities, and there would be no budgets and no financial planning. Consequently, there would be no accountability.
CalPERS went on to say that even if the pension obligation is a debt, it is a contingent obligation. But, the debt is contingent on past events, specifically on obtaining approval by a former group of supervisors. As the contingent event has occurred, to an accountant this is a full-blooded liability and not a contingent debt. Perhaps CalPERS is trying to say that the obligation is contingent on future retirements and how long the retirees live and similar events. If so, this argument renews its attack on actuarial science; as such, it is merely a morph of the estimation argument, which is fallacious.
The second major argument provided in the CalPERS amicus brief is that the California constitution allows extra compensation when the entity receives benefits from the other parties. That may or may not be so in those instances in which the benefit depends on continuing work, but it is patently false in those cases in which the benefits are awarded for work already completed. Whatever past benefits were provided to Orange County are historical; they will supply no additional benefits to Orange County in the future. This argument is not only a straw man, but a moldy one as well.
The third argument given in the brief is really a statement of the consequences if the Court recognizes the economic reality of pension obligations. CalPERS declared, “If this Court adopts the County’s unprecedented claims, the pension benefits of all of these employees and their dependents could be threatened.” This assertion exaggerates what is contested in this lawsuit—plaintiff has focused on the unfunded pension liability due to the enhancement for prior services and the respondent has incorrectly broadened the claims to other pension benefits as well. Even so, governing law and economic reality should guide the Court’s decision making and not the potential consequences.
As an aside, I do not worry about public employees because they have been enjoying the good life. The US Department of Labor reports that private sector workers earn on average $27.42 per hour while state and local employees make $39.60 per hour. I know of no economic reason to explain the disparity.
The L.A. Daily News reports that over six thousand employees of Los Angeles have salaries of more than $100,000 per year. Given the lower pay for regular taxpayers and the high salaries for public employees, it is no wonder that taxpayers are showing signs of an inability to pay for the excessive compensation in the public sector.
My main concern, however, is whether we analyze these enhancements to pension benefits correctly. The enhancements are undoubtedly liabilities. If the Court says otherwise, it will be showing its support for accounting lies and will contribute to the mess in financial reporting as much as any of the corporate scandals in the last ten years.
A footnote to this brief: it was prepared by Attorney General Jerry Brown who is running for the governor’s office this fall. The question is why he supporting Enron-like accounting for California. Recall that Enron repeatedly disguised its debts by either treating the transactions as sales (e.g., the Nigerian barges transactions) or by ignoring them (e.g., the non-consolidation of many of Enron’s special purpose entities). To refuse to call pension enhancements a liability is on par with what Enron did.
Perhaps it isn’t that bad. Maybe Jerry is just scrounging for votes and hopes to garner the ballots of public employees. Even so, the price is too high to pay.
